Hey Mesoblast, where’s the fruit?

Exactly 6 months and 3 days ago, Mesoblast (ASX : MSB) announced with much fanfare the AUD $58.5m investment in Mesoblast by Celgene. At the time, it didn’t raise much of an eyebrow for me, mainly because as a “small cap” guy I don’t generally find Mesoblast all that interesting. It’s an anomaly. It’s more tightly held than a gnat’s posterior. To be honest, MSB mostly defies explanation. 

From a “Long Tail” perspective it’s also probably safer to get GVHD than throw rocks at Mesoblast. Besides, I have to admit that I sort of admire Silviu. I don’t like everything about Mesoblast but if we had a few more ambitious and capable CEOs like him, with a real desire to build $Bn companies rather than just fleece shareholders, Australia’s biomedical sector would undoubtedly perform a hell of lot better than it does.

However there comes a point when even the great Mesoblast isn’t immune from scrutiny and … exactly 6 months and 3 days ago … Mesoblast’s CEO and Managing Director Silviu Itescu commented in an ASX disclosure “We are pleased that Celgene, as a global leader in development and commercialization of innovative therapies for oncologic and immune-mediated diseases, has chosen to make this investment in Mesoblast. We look forward to working closely together and building a strong and fruitful relationship.”

So where is the fruit?

Recently I’ve felt there is something odd going on at Mesoblast. There is no doubt that the financial investment in Mesoblast by Celegene was a major event, but so was the highly downplayed six-month right of first refusal (ROFR) with respect to Mesoblast’s proprietary mesenchymal lineage adult stem cell product candidates for the prevention and treatment of acute graft versus host disease (GVHD), certain oncologic diseases, inflammatory bowel diseases, and organ transplant rejection. Basically a substantial chunk of the value of the company. At the time I thought this was a super cheap ROFR given that the equity purchase wasn’t at much of a premium, but it was hard to be too critical when MSB had just picked up a top-class investor that is clearly taking a bunch of big bets in cellular therapies.

As an aside note – it’s generally recognised that Celgene’s current cell therapies pipeline isn’t all that crash hot and there has been speculation for a while that they would spin out the CCT subsidiary (it was mostly developed through acquisition anyhow, going as far back as Anthrogenesis in 2002). This speculation has been somewhat reinforced by a spate of relevant investments over the last couple of years, including the June deal with with Juno (Juno in June!) at an eye-watering premium, indicating the company is truly looking outside its own walls to bolster its reputation in the space.

Going back to Mesoblast … there isn’t much evidence of a smoking gun but today’s ASX announcement about the extension of the Celgene ROFR is probably as close as we are going to get. Let’s call it a little gunshot residue on the hands… Why? Well, the answer may lie in the concurrent analysis of five “thoughts” about the current MSB state of affairs.

The first thing that bothers me is that MSB has basically never been cheaper. Since the April Celgene investment, Mesoblast’s news around the GVHD program has been pretty darned good and so you would think that a cashed-up and aggressive company like Celgene would be more than a teeny bit interested in the company’s pipeline if it had any sort of real intent. Especially since the stock price is actually lower than when the deal was done six months ago (Japanese approval notwithstanding), with another 10c drop on USD ForEx to boot. Basically, it is my opinion that MSB is about as cheap as it is ever going to be as a product-stage company so if Celegene is genuinely interested, they should be buying up and not renewing ROFRs.

The second concern relates to the Juno deal. This deal was “classic” Celgene – make an investment, become a business partner. Of course that deal was a hell of a lot bigger, but the point is that Celgene paid a premium for commercial access. This didn’t happen with the MSB investment and in comparative hindsight, it raises an eyebrow. Taking today’s announcement into consideration raises even further questions because Celgene got the ROFR extended for another six months but didn’t apparently pay anything for it (if they did, it should have been disclosed). This either means that the ROFR isn’t really of intrinsic or competitive value to Celgene, or it’s a smokescreen for something else going on. My bet is on the latter.

The third thing that bothers me is the ROFR itself. Companies like Celgene don’t take out a ROFR unless there is someone else sniffing around a potential acquisition target, and they want to ward others off (and thus they usually also pay handsomely for it). But to renew a ROFR, free of charge, is usually sends a really bad signal – it sort of implies that nobody else has stepped up to the table (hence the freebie) or that it is taking an unexpectedly long time to do whatever deal is going on in the background. Hot deals for hot companies get done quickly. Only complex or marginal deals get time extensions. Therefore whatever is happening in the background isn’t as simple as Celgene taking over the shop.

The fourth “combo” issue is MSB’s need to raise capital and the current short position on the company. Based on everything MSB has going and current/anticipated burn rate, it probably needs to raise another $200m to execute over the next 24 months. However notwithstanding a product approval and a lot of other good stuff happening in the company, the share price hasn’t tracked and although the current short position is less than it used to be (down from about 7% I think), it still reflects about 3% of issued capital. For a company as tightly held as MSB, this is still a pain in the ass when it’s time to go out for big fundraising.

Finally – MSB need a big story. The company has been very successful but I think the general consensus is that the current market cap is “about right” given the pipeline and even factoring in the Japanese GVHD approval. Because MSB didn’t get the pop it probably wanted on the back of Japan, it sort of leaves me scratching my head and asking what the big story is going to be in order to go out and raise another $200m at a decent valuation. MSB’s pipeline is good but it isn’t a slam dunk and it probably needs a bit of star power in the investor memorandum, which is possibly currently lacking. This is why the Celgene story is so interesting… yet isn’t it slightly odd that in the latest annual report released a few weeks ago, the Celgene relationship is downplayed almost to the point of non-existence, and the ROFR gets little more than a single footnote mention on page 74 in the financial reporting section?

Putting all these thoughts together, I have cobbled together theory as to what is going on and it stems from guessing what each company needs from the other. Celgene wants to be a dominant player in the cellular therapies space but to do so, it probably needs to clean itself out and make way for a new product pipeline. I think MSB is the perfect repository for Celgene’s current pipeline and we saw from the Osiris deal that MSB doesn’t mind rat-packing assets to tell its story. MSB needs a bigger story if it is going to pull in $200m and if it did a combo asset/investment deal with Celgene, this could go a long way toward beating a path to that kind of a capital raise. The existing cellular therapy assets (at least the ones in the public domain) aren’t a bad fit for MSB’s portfolio either and may even benefit from some of MSB’s technology platforms. MSB also really needs a vicious tool to scrape off the shorts before it does that kind of a monster raise so that pre-financing valuation is as good as it can be and post-financing stock appreciation isn’t fettered – hence the ROFR (and ROFR renewal). If you are a short investor, this kind of a deal would be near madness to try and ride out and we all know that the shorters are Itescu public enemy #1 anyhow.

Even if today’s ROFR extension wasn’t the heartening news that shareholders were expecting, it should make those that are crazy enough to still be holding short positions sweat extra hard (no doubt this will make Silviu smile in his sleep). Certainly any bump in share price is more likely to be more reflective of burnt-out shorts hitting the road, than the market “delighted” with mediocre news.

 

 

24 thoughts on “Hey Mesoblast, where’s the fruit?

  1. Hi,
    Would you care to comment more on the scientific/clinical aspects of the company’s technology that you find the most compelling (if they exist)? They are the biggest and have first-mover advantage but beyond that I don’t see their stem cell technology or development program as unique.

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    • Gee Pete, no loaded question there?

      I think the MSB/Osiris portfolio in ortho is pretty solid. I think they have probably got the strongest clinical experience in CHF and I think their cell expansion technology is very interesting. Obviously getting a product to approval in GVHD is no small feat, keeping in mind the manufacturing complexity of these kinds of therapies – plenty of IP/know-how there. Are there things I don’t like about MSB’s clinical programs?… yes, and they are well known. But nobody can really dispute that the company is a pioneer.

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  2. I’ll leave it to others who are more qualified to comment on the technology, but I think your analysis of the ROFR deal is worth expanding on. Any listed biotech company who makes a key asset subject to a ROFR takes a huge risk – if the potential acquirer/licensee walks away from the ROFR you are suddenly dealing with a major public rejection. You can further magnify this risk by (a) making a substantial chunk of your core business subject to the ROFR (tick) and (b) giving the ROFR to a key potential acquirer (tick). I think much of the problem here lies with the original deal structure.

    As for the extension, I would simply ask: how does MSB look if the ROFR was allowed to expire? From Celgene’s point of view, if you’re offered a free extension to an option, logically you would simply take it, whatever stage your DD is at – the downside is negligible. But the fact it appears to have been given away suggests a lack of competitive tension for these assets. In the end, a free extension of the ROFR (rather than expiry) ends up being the lesser of two bad outcomes.

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    • Yes, I agree… Of course if the ROFR is just a smokescreen for some other kind of deal, and the goal is to create an incalculable upside in order to scare off (or crush) shorters, the extension really raises the stakes in an interesting way.

      We may be over-analysing all of this, but it is fascinating nonetheless.

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  3. So just adding to the thinking in regards to this speculation – are you proposing that the ROFR extension is aimed to squeeze the shorters, before a monster Mesoblast cap rasing to fund purchasing Celgene’s cell therapy business + finance Mesoblast’s $200m financing needs…?

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    • Pretty much. I am of the opinion that to do a monster raise, the company needs to have a bigger story than what it does today. Both Celgene and MSB have certain needs that can be satisfied by the other. It’s a win-win and gives Celgene another interesting bet….

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  4. WIth MSB suddenly going straight into a suspension I thought it might be a good time to revisit this thread. I can see where you are coming from with your a good story but could be better with a bigger bang theory. Perhaps you are about to get it.

    Couple of things stood out. First:
    . Based on everything MSB has going and current/anticipated burn rate, it probably needs to raise another $200m to execute over the next 24 months.

    Well, I have always maintained that a marketplace is not the natural partner for valuation in biotech as there really is no rent seeking (price gouging) to be had without product in market. Therefore, the valuation has to come from an independent third party.

    Depending on how the industry gets restructured, that third party could be a pharmaceutical company, an insurer or a state funded entity. Possibly a combination of all three. If the structure is right, agency costs would be reduced at the front and back end of the PDLC resulting in either cheaper drugs or a more egalitarian distribution of the margin.

    To that end, I wonder if the IPO MSB is about to undertake will throw up a surprise partner paying some exorbitant price in a PIPE pre-IPO providing you with your bigger bang than CELG story.

    The second:
    MSB also really needs a vicious tool to scrape off the shorts before it does that kind of a monster raise so that pre-financing valuation is as good as it can be and post-financing stock appreciation isn’t fettered

    A PIPE at IPO would fit the bill perfectly. In addition to MSB, it would not be stretching the bow too far to imagine that other complimentary biotechs that are involved in modifying the stem cell before it is put back in to the host will also be involved. To that end, I am on the look out for more trading halts this week. Think, CIR, BLT, PYC etc. Or, the Longtailers as I like to call them, all ending up in the one melting pot.

    We shall see.

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  5. IPO is referring to the statement made last week about them seeking a listing in the US. We could quibble the detail but the headline states “registered IPO”.

    PIPE, public investment in private equity. If an entity were to take a cornerstone and licence agreement in this IPO, much the same way Novartis did with ALNY, at a significant premium to current market price then in my mind that qualifies as a PIPE. However, I am thinking there could be more than one party. Valuation is then priced according to those informed of the science and how it pertains to their market expertise, not those knowing the revenues. Remember Sirna? More recently, GENZ/Sanofi and ALNY.

    We may even see CSIRO getting in on the act. Kind of doubt though. Their pie will come from IP revenue cuts.

    But I don’t know the details. I am only talking in the context of what I imagine the perfect outcome ought to be.

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  6. Such an outcome would qualify as having satisfied your need for a bigger bang story whilst simultaneously killing the shorts I think. Don’t you?

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    • It would … sorry for my vague comment about the IPO before, I just never think of a “US IPO” as an IPO, but rather a secondary listing.

      The truth is, Mesoblast – or for that matter any Australian biotechnology company – doesn’t need to dual-list. It’s mostly a farce. If an Australian biotech company needs to list in the US, it means it wants to tap retail capital and it probably also means that the instos aren’t all that impressed.

      A public company is basically a public company.

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  7. Hi Christian, you previously mentioned : “…. Are there things I don’t like about MSB’s clinical programs?… yes, and they are well known.”

    Are you referring to scalability in manufacturing? Or other issues?

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  8. Pingback: Mesoblast in Black & White | The Long Tail

  9. Pingback: MSB Revalued | The Long Tail

  10. Given the latest share price falls (on fairly tasty volumes) I was wondering where your thoughts were on the MSB story. Raising the couple of hundred million needed to get them through the coming 24 months will be even more challenging now – are they an acquisition target or does anyone really want them? Or what the heck is going on :-))

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    • It’s a very defining moment. I think between their existing balance sheet and the recent NASDAQ raise they are ok for cash. They will need to prioritise some of their pipeline and run a bit leaner but there is no real risk there.

      I think this has been a massive valuation correction that clearly rolls the dice for anyone thinking of taking them out. The big question for me is this – what happens if nobody does? If the Celgene ROFR falls through without action I would expect to see another major devaluation. By NASDAQ standards, this company isn’t worth more than $500m, so it’s within range in my opinion.

      I am very sad about Mesoblast because it cements the notion of the Down Under Discount and I think that is a shame. It does, however, send a very strong message to all those CEOs out there that think they can just shovel out a bullshit “Mesoblast v2.0” story and think they can ride the wave.

      It’s very sobering and time for a bit of reflection in the industry about our business culture and how we project our excellence abroad…

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